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It was probably only a matter of time before China and Google would find themselves in a major conflict. On the one hand, you have an authoritarian government that believes it has the right to censor information available to its citizens. On the other, you have a California-based Internet company committed to the free flow of information.

The confrontation began in January when Google announced that computer hackers based in China had stolen some of the company’s source code and broken into the Gmail accounts of Chinese human-rights advocates. Earlier this month, Google halted operation of its Internet search engine on the Chinese mainland and started directing users to its Hong Kong site, which is uncensored. Chinese officials retaliated on March 29 by blocking some of Google’s mobile Internet services.

How will Google’s actions impact its long-term plans for operating in China? And what lessons can other multinationals learn as this story plays out? Knowledge@Wharton asked Wharton management professor Marshall Meyer and marketing professor John Zhang these and other questions.

Knowledge@Wharton: Google has moved its search engine to Hong Kong, but has kept its other businesses — sales, research and other operations — in China. What does Google hope to gain by taking these steps?

Marshall Meyer: I don’t know what they hope to gain, but I have a sense of what they hope to lose. It has been tough doing business in China. Google’s market share [before the launch of the search engine] Baidu was about 30% in China. And even before this recent announcement they were down to 15%.

Knowledge@Wharton: And Baidu is Google’s main competitor in China?

Meyer: It is the largest Internet operation in China by far. And the experience at Google has paralleled almost all of the Western invested or foreign invested Internet companies like Joyo, Eashnet, Elong [and] 3721, which I think is Yahoo.

I actually had some experience with [flight booking web site] Elong. I tried that [site] before I tried CTrip for making plane reservations in China. And I remember all these screaming emails I sent to people around Wharton [saying] I can’t make plane reservations in China because they won’t take my Western credit card. That was Elong. Then I discovered that CTrip would.

So there seems to be some home-team advantage — that’s a nice way of putting it — for Internet companies in China. And I think that by moving to Hong Kong, Google got rid of one — but only one — disadvantage. The disadvantage is, first of all, you are a foreign company. A lot of your decisions are made outside the country. They take time. You’re not responsive. That goes almost without saying.

There are issues of Intellectual Property [IP] protection. The rules in China are different …. Aside from IP protection, there is the issue of legal restrictions on disclosure — for example, on the names associated with different IP numbers. This is what got Yahoo into trouble in 2006 and 2007.

And there is something else I just want to draw a little attention to. A further disadvantage in China is interference. My students tell me that their Google accounts would go on and off almost randomly. There are stories going around Beijing — I don’t know whether they are true. I hear from students that Baidu would monitor Google sort of on behalf of the government. And when Google would come up with a page that violated censorship rules, Baidu would run down to the police station, and the police would pull the plug making Google’s service very intermittent…. By moving to Hong Kong, this last problem at least is solved. Others may be created. But no one is going to run to the Hong Kong police and have the switch turned off on Google. That is a quick rundown.

John Zhang: Well, it’s very difficult for me to see how Google could gain anything inside China. I think outside of China they probably would gain something in terms of public opinion. And I think that you also have to look at the dog [that] did not bark. I think the fact that multinational companies did not stand up and speak in favor of what the Chinese government has been doing … probably speaks well for what Google has done inside China. I think they certainly score a PR point from a Western company’s point of view.

Knowledge@Wharton: Yet Google has not pulled out of China entirely. Is that correct? They still have some sales people and R&D people on the mainland, I think.

Zhang: They do. They actually want to play both sides. But it looks to me that by moving the sort of online operation to Hong Kong and by not following the laws inside China, they may have poisoned the business environment for the company. So it is hard to say that, in fact, in the near future business may not suffer there for Google.

Knowledge@Wharton: Marshall, if this dispute continues for weeks or months or even longer, what does Google stand to lose if the Chinese authorities prevail in their attempt to say that we must be able to censor your search engine or else you cannot do business here? And secondly, what does China put at risk by showing the world and its own citizens that it is taking a hard-line stance — [and] that it may take an even harder line stance with Google?

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Meyer: Well, Google stands to lose a relatively small market share in China and whatever profits associated with that today. In the long run, the losses could be much, much larger given the size of the market and given the intrinsic appeal of Google. So they are at risk. China stands to lose something else. First, of course, is open expression. For many Chinese, I think that this is an issue, but for many perhaps this is not an issue. Maybe John wants to speak to that because social stability is a deep-seated value in China. People are very, very worried about — all people are worried about — the spreading of unwarranted rumors and the potential for civil unrest. That is a fact of life in China, which may not be fully appreciated in the West. The bigger loss to China, in my judgment, is the pressure that Google puts on domestic competitors. Ultimately, Baidu can’t be globally competitive without pressure from a strong firm like Google. And my guess is that, at least commercially, that is the major loss China stands to suffer in the long run.

Knowledge@Wharton: Would it also stand to suffer a loss of prestige internationally? It seems to be an obvious thing they would stand to lose, but is that just kind of a foregone conclusion?

Meyer: Well, I think it adds additional evidence to what people have known all along, and that is in the Internet space and telecom space [it is] very difficult to do business in China. The question is whether Western countries — or I should say non-Chinese countries — are going to respond to some very aggressive marketing by the Chinese telecom firms. For example, Huawei and ZTE have invested globally, even in the United States at this point. I think Huawei is down in Texas now. Whether there will be retaliation I can’t judge. But it seems to me that the potential for some push back in other domains is increased a bit.

Zhang: I actually agree with what Marshall was saying in that I think the telecom sector is definitely a strategic sector in China. And [the] Internet sector is also a very strategic sector in China. In fact, the censorship is not going to go away, and the problem is not going to go away for a long time to come. Given that, obviously Google could suffer in the short-term and also in the long-term simply because, as I was saying before, they have poisoned the business environment from some of the Chinese perspectives. Given that, it is probably a little bit harder for Google to do business in China. But that’s only one possible scenario.

I think the other possible scenario is that in China there is a saying that in fact if you fight with somebody, you probably have a better chance to befriend that person. In this particular case, there is a distinct possibility that the Chinese government may decide that not only do they want to keep their friends close, they probably want to keep the enemies closer. Hopefully, Google may actually sort of benefit from the backlash simply because, from the Chinese government perspective, it really has every interest in making sure that multinational companies continue to operate inside China profitably so that ultimately they will contribute to the Chinese economy and also bring new technologies to China. I think that’s really the long-term interest for the Chinese government.

If you look at Google as a company, it is very innovative. It is a pioneer in the information age industries, and in fact they have many other innovative products that are available that are very much appreciated by customers inside China. Given all that, I am hopeful that in the longer-term Google could still benefit from the big market inside China.

Knowledge@Wharton: What about the way Chinese consumers, Chinese Internet users, view Google and its competitors in China? Are they viewed as very similar search engines, in that you use one or you use the other depending on how you feel that day? Or do they view those companies in a very different way?

Zhang: My sense is that in fact most Chinese customers will use Baidu. And obviously that is in the Chinese language. It has a lot of different features that Chinese customers actually like. But certainly Google … has a lot of scholarly articles, for instance, that [contain] a whole lot more information. English language searches obviously are very, very important for a lot of intellectuals and scholars inside China. In a way, Google has been playing this catch up game for quite some time now…. I also agree with what Marshall was saying earlier — that Baidu may be in a tougher situation now because of the fact that Google has withdrawn from the market. The reason is because Google has been the company that was more outspoken about all the censorship and everything else. You can imagine that, if Google is gone, obviously Baidu is going to suffer the brunt of all this regulatory pressure. And so given that, I think that Baidu may not really be celebrating that much about the Google withdrawal from the Chinese market.

Meyer: I’ve never used Baidu but I understand that a lot of folks in China go to Baidu, particularly to download MP3s. They are generally not available on Google because of Western IP laws. So there was this difference between them. [People] will continue to go to Baidu or other local search engines for MP3s. I fully agree with John’s last comment. I think that was absolutely insightful — that now the pressure is going to be on Baidu. I also think, just on a slightly different dimension, that Google’s act is not out of the blue. I went back and looked at the experience of Yahoo at the time they were hauled in front of the U.S. Congress for disclosing names of folks alleged to have released State secrets. They were sued and settled in the U.S. courts under [an] obscure law. This was the Shi Tao case — a Chinese [person] who disclosed on a blog certain changes, I believe, in personnel regulations. Things we wouldn’t consider important, but were treated as State secrets there. And he was tried and imprisoned after Yahoo gave up to the Chinese government his identity. The family sued in U.S. courts. The suit was not decided, but was settled, I assume, for a fairly substantial amount of money.

But in any case, at that time, Google stated their principles and it seems to me that they have pretty much stuck with their principles. I actually wrote down a little bit of Google’s testimony in front of the U.S. Congress. This is from their vice president for public affairs: “If over time” — this is 2006 — “we are not able to achieve our objectives in China, among those objectives freedom from censorship, we will not hesitate to reconsider doing business in that market.”

So I wasn’t surprised actually by what happened. And I imagine, for reasons John pointed out, there are some really disappointed consumers there. But I wanted to ask you a question, John, because this is really your area of expertise. You remember [the direct selling company] Amway? … They left China ….They returned to China …. Is a repeat possible?

Zhang: Well, I think it definitely is possible because … it could very well be that eventually Google will be invited back into China under more favorable terms to both sides. I think that is really a distinct possibility. As long as Google is doing well and is churning out a lot of innovations, I’m sure that eventually Google is going to be welcome everywhere, including China.

Meyer: The Chinese government — I can’t put an exact date on this, maybe John can — outlawed direct selling in China.

Zhang: It is not the direct selling. It is essentially that you would actually sell to your friends; your friends would sell to your friends, and so on and so forth. You can imagine that could be a problem inside China, simply because you do get those people organized. Not only get those people organized, [but] some of the customers may actually suffer simply because they carry out their end of a bargain but somebody else has not carried out their end of the bargain. In the end, somebody is going to get squeezed in the middle. And because of that, obviously for the stability of the society … the Chinese government basically decided that it wanted to ban that practice. As far as I know, Amway is back in China. And I don’t know the new terms that were set up for the company, but certainly they are operating in China today.

Knowledge@Wharton: Let’s take a minute or two to talk about the Google experience and what it says about the overall experience of multinational companies in China. Is this just the latest chapter in an ongoing string of difficulties that companies have experienced? Or is the Google case something new, different, more significant, less significant?

Zhang: I used to study history and so if you take a longer perspective and go back to, let’s suppose, around the 1850s or whenever Western countries began to open up China, there was a term at the time called [the] China Dream. I think that a lot of Western companies did have a China Dream. And then they soon find out that in fact it is not that easy to do business in China. Of course, there are some good reasons for that. Certainly, China has a different culture, has different people and a different way of doing business. And you also realize that China is a Socialist or Communist country that has a different governance structure … which means that if you want to be successful in China you really have to be able to adapt yourself and you really have to overcome some of the barriers inside China. You have to follow the laws in China and do a lot of things that you probably don’t do in Western countries.

Given that, obviously it is understandable that some multinational companies find the Chinese environment not to be the same as in Western countries. And they find somehow that doing business is not that easy. And I think that problem probably is going to be there for a long time to come. But in the meantime, look at some companies like GM, [which] is doing badly in the U.S., but is doing very well in China. If you know how to operate and if you are willing to adapt, there are opportunities inside China, and some companies could in fact realize their China Dream.

Meyer: Some can. Some can’t. GM has done pretty well. An argument might be made that Volkswagen has done better because they now have three joint ventures in China. GM has got one very large one, but VW is up in the north of China with First AutoWerks in Shanghai and opening up down in Dongguan, and it may threaten Toyota’s lead as number one globally with all of this China capacity.

Procter & Gamble has done very well in China. But some other companies haven’t, for example [French food products company] Danone. … They got whooped pretty badly by Wahaha, a beverage manufacturer coming out of Hangzhou, and weren’t able to get a toehold in any court proceeding, or even arbitration proceeding, when contract violations [and] IP violations were alleged. So there are a lot of chance elements here. I don’t know if there are any iron rules for doing it right or not doing it right, doing it successfully or not doing it successfully. There is just a lot of variance.

Zhang: It’s almost like playing a game, and obviously there is some home court advantage [for] the domestic companies. I think that is something that probably Western companies have to recognize. With that said, you also have to worry about the fact that the business environment is getting increasingly tougher for multinational companies. If that is the case, obviously, there has to be something to be done about it.

Obviously, at this point there seem to be more complaints from multinational companies inside China. The fact that a lot of Western companies did not stand out and speak in favor of what the Chinese government did and urge Google to go back to the basics and follow the Chinese laws and so on and so forth — that really is a very good indication that some of the companies may not be very satisfied with what is going on inside China.

The Chinese government, in fact, is very sensitive to that based on what I’m reading in the [press] coming out of China. The Chinese government is talking to the business communities inside China and trying to see what other things that can be done. A lot of companies have noticed that over time, the Chinese marketplace has seemed to become a little bit more nationalistic. You can imagine that given the financial crisis … obviously that is a very sensitive issue for multinational companies and it also affects the interests of a lot of Chinese companies inside China.

Meyer: There’s not just nationalism. There is some degree of subsidy for domestic companies. There are some informal [subsidies], I believe, in China. … In the countryside … the greatest worry always is that the government is subsidizing, for example, purchases of large household appliances made in China. So it is becoming a little tougher for many, many reasons going beyond nationalism.

Knowledge@Wharton: Is there any reason to think that non-Chinese companies, that are doing business in China would stand to benefit from somehow marshalling their forces and collectively petitioning, or putting pressure on, Chinese authorities to loosen things up a little more and make it easier for these companies to do business? Has that ever been tried or is that a non-starter?

Zhang: I’m not too sure that’s a desirable approach. Certainly, that particular approach doesn’t work for Chinese companies. There is no way that Chinese companies can actually get together and somehow petition the government to do certain things in a very sort of open, and probably confrontational, way. And certainly that won’t work for Western companies. If anything, you probably want to do something behind the scenes — probably work on your relationships and discuss some of the general long-term interests with government officials. That probably is the more preferable approach for the Chinese government. It is hard to actually come up with a case where somehow an open confrontation has ever generated good results inside China. I think that probably is not something most companies would want to do.

Knowledge@Wharton: How do you think the China-Google dispute will play out?

Meyer: [It's] unpredictable. Why is it unpredictable? First of all, as John pointed out, we are dealing in a strategic sector. We are not talking about steel, automobiles and so forth here. We are talking about communications, content, what people hear, what they see. So it is of special interest to the government. Secondly, there will be a change of government in a couple of years. It is not clear who all the players are going to be. It is pretty clear who some of them are going to be, but it’s not clear who all of them will be. And so it’s not clear what the policies will be. And shifts in policy can go in either direction. This government … seems to have tightened up, more than a bit, on control of information, the treatment of dissidents and so on. Who knows? This could be relaxed. It might not be, but if it were relaxed I think it would change the environment for Google and they could confidently step back in, if slowly. And the other unknown is a behind-the-scenes, face saving deal for both sides. You just can’t predict how they are going to behave outside of public notice.

Zhang: My sense is that censorship is just so fundamental and, to the Chinese government, so essential, there is no way that they would actually give up on the censorship to please a particular company. That is never going to happen. Given that is not going to happen, obviously censorship will be there and it will affect Google’s business. Given that Google has already taken this very public, principled stance, in the short-term Google’s business is going to suffer somewhat — and in fact we are already seeing that in the marketplace.

The good thing is that the shareholders don’t seem to care that much about it, and the share price for Google hasn’t really suffered much. That probably is a good thing for Google. In the long run, most likely what will happen is that Google is going to be marginalized inside China. Obviously, it would reflect very badly on the Chinese government if it takes some systematic measures to squeeze Google, because the world is watching and a lot of multinational companies are watching the case with a very keen interest. If the government [wants to do] the right thing, it would not try to do something to squeeze Google.

On the other hand, given that its search engine is gone and it is competing with a lot of other companies for a lot of other business, it’s very easy to erase the impact of Google over time and make Google marginalized in the long-term. That is one possible outcome. But, of course, if Google keeps innovating and comes up with some really good technologies that are inseparable from all these online operations, I’m sure that, eventually, Google will come back and do well there.